Blockchain & Money: Session 8: Public Policy by M.I.T. Sloan School of Management with Professor Gary Gensler

Session 8: Public Policy

• Session 8 Study Questions:
  • How do key public policy frameworks–guarding agains illicit acticities, ensuring financial stability, & protecting investors–relate to blockchain technology and crypto finance?
  • Under tax, bank secrecy, securities & commodities laws, what is the relevance if crypto tokens are deemed property? Currencies? Something of value? An investment contract? A commodity? What is the essence of the U.S. Supreme Court ‘Howey Test’?
  • How might the ‘Duck Test’ guide thinking of blockchain technology and crypto finance?
• Session 8 Readings:
  • ‘Cryptocurrencies: Oversight of New Assets in the Digital Age’, Gensler.
  • ‘The Future of Money’, Carney.
  • ‘Nobel-Winning Economists: Authorities will bring down ‘hammer’ on bitcoin’, CNBC.
• Overview: Crypto Finance; Public Policy Framework; Guarding Against Illicit Activities; Ensuring Financial Stability; Protecting the Investing Public; Public Policy Development; Conclusions.

• Incumbents Eying Crypto Finance:
  • Crypto’s market cap, trading volume, volatility & spreads are drawing attention.
  • So has Coinbase’s 20 million account, about as many as Fidelity Investments, twice Charles Schwab, and nearly as many as Vanguard.
  • Startups more willing to beg for forgiveness while incumbents often need to ask for permission.
  • Incumbents interested to serve customer interest; gain a share of profits; & protect their franchises.
    • Exchanges–CME; Eurex; Intercontinental Exchange; Nasdaq
    • Assest Managers–Fidelity
    • Investment Banks–Goldman Sachs

• Public Policy Framework [*Some (many) think that any broad economic activity with crypto will require public policy frameworks!]
  • Guarding Against Illicit Activity (i.e.–Tax Evasion; Money Laundering; Illegal Trafficking; Sanctions; Terrorism.)
  • Financial Stability
  • Protecting the Investing Public (i.e.–consumer protection; investor protection; Watchdog groups)

• Public Policy–View From the Top:
  • “Authorities need to decide whether to isolate, regulate or integrate crypto-assets and their associated activities.” –Mark Carney, Governor of the Bank of England, March 2, 2018.

• Global Approach to Crypto Finance: (Still Early Stage, but Confidence is Built upon coming within Public Policy Norms)
  • Guarding Against Illicit Activities
    • Broad Consensus on Policy
    • Inconsistent on Implementation
  • Financial Stability
    • General Consensus to Monitor
    • Different Perspectives, though, on level of risk.
  • Protecting the Investing Public
    • Wide Range of Views on ICOs & Exchanges
    • Japan, U.S., & Others Moving to Regulate Exchanges
    • U.S. & Canada seeking to bring ICOs within Securities Laws.
• Bank Secrecy Act
  • KYC–Know Your Customer
  • AML–Anti-Money Laundering laws

• Crypto Public Policy Challenges–Guarding Against Illicit Activity
  • Tax Compliance and Reporting
    • Definition–Currency or Property?
    • Tax Treatment–Mining, Exchanges, & Forks?
    • Reporting–Individual, Brokers, 1099-Bs & FBAR
  • Bank Secrecy Act
    • Money Transmission Laws (AML, CTF)–Users vs. Administrators or Exchangers
  • Challenges
    • Pseudonymous Addresses
    • Privacy Coins & Mixers or Tumblers
    • Compliance and Reporting
    • Crypto to Crypto Transactions
    • Decentalized Exchanges
    • Dark Markets
    • State Actors (other governments)

• Property vs. Virtual Currency
  • Dept fo Treasury refers to it as both:
    • Virtual Currency, which happens to be property for tax law.

• Crypto Public Policy Challenges–Financial Stability
  • Financial Stability Board– Initial Assessment
    • Crypto Finance Still Modest in Relation to Global Capital Markets
  • Capital Control Countries–Concerns on Maintaining Stability.
  • On the Horizon for many countries though…
    • Crypto Leverage
    • Blockchain Market Infrastructure
    • Central Bank Digital Currencies & Stable Value Tokens

• Central Bank Concerns on CBDC
  • Potential of pro-cyclical runs to CBDC
  • Changes to commercial banks’ deposits & funding models
  • Effects on credit allocation & overall economy
  • Monetary policy implementation & transmission
  • Resilience of open payment infrastructures
  • Guarding against illicit activity
  • Central Bank Digital Currency, though, likely will be seen in adoption

• Crypto Public Policy Challenges–Protecting the Investing Public
  • Crypto Markets Readily subject to Fraud, Scams, and Manipulation
  • Custodial Arrangements–Exchange and Wallets
  • Definitions–Securities, Commodities, or Derivatives?
  • Tracking Beneficial Ownership of Crypto Assets
  • Remediation of Non-compliant ICOs & Exchanges
  • Personal Data Privacy
  • (Securities & Exchange Act 1933 & 1934)

• Investor Protection
  • Investor Protection goes beyond Consumer Protection:
    • Investors get Full & Fair Disclosure from Issuers
    • Fraud & Deceptive Sales Practices Prohibited
    • Secondary Markets Promoted with Price Transparency & Anti-Manipulation
    • Advisors’ Conflicts of Interest Disclosed and Minimized
  • Investor Protection Bolsters Confidence in Capital Markets
  • Economic Growth, Issuers, & Investors all Benefit!

• U.S. Securities Law
  • The Howey Test (1946):
    • Is it an investment of money or assets?
    • Is the investment in a common enterprise?
    • Is there a reasonable expectation of profits?
    • Is it reliant on the efforts of a promoter or others?

• The Duck Test
  • “When I see a bird that walks like a duck and swims like a duck and quacks like a duck, I call that bird a duck.” –James Whitcomb Riley, poet

• Initial Coin Offerings–Crowdfunding for Investment & Consumption
  • Proceeds used to build networks
  • Tokens usually issued prior to being functional
  • Development, while open source, is largely centralized
  • Promoters allocate themselves ‘premined’ tokens
  • Tokens are fungible & transferable
  • Scarcity is fostered with preset ‘Monetary policy’
  • Purchasers anticipate profits through appreciation

• Initial Coin Offering–Investment Schemes Warranting Investor Protection
  • False Distinction between ‘Investment’ & ‘Utility’ Tokens
  • Most ICOs, Currently Issued Outside of Investor Protection Laws
  • Significant ICO Fraud and Scams–Est. of 25% or as high as 81%
  • Over 70% have Declined Value
  • Investor Protection Frameworks go beyond Consumer Protection Laws
  • Economic Growth & Issuers benefit from Investor Confidence

• Crypto Exchanges
  • Critical gateway to implement public policy & instill confidence.
  • Responsible for vast majority of crypto secondary market.
  • Greater than 30 million direct members.
  • Lack brokered access or meaningful market integrity rules.
  • Custodial wallets are honey pots for hacks.
  • Decentralized exchanges present new opportunities & policy risks.

• Crypto Public Policy Challenges–General Considerations
  • Adapting Existing Laws & Regulations, where appropriate.
  • Staying Abreast of Technological Developments
  • International Regulatory Arbitrage

• Public Policy Development
  • Messaging + Politics + Analysis = Policy!
  • “Personnel is Policy”

• Conclusions:
  • Blockchain Technology has potential to be a catalyst for change
  • Addressing challenges could lower Costs, Risks, & Economic Rents
  • Broad Adoption requires coming within Public Policy Framework
  • This is consistent with Technological Innovations in the Past
  • We still must guard against illicit activities & ensure for financial stability.
  • Public Confidence can only be built on Investor Protection
  • Consumer Protection Frameworks will not be enough

• Biblio:
  • Gary Gensler. 15.S12 Blockchain and Money. Fall 2018. Massachusetts Institute of Technology: MIT OpenCourseWare, https://ocw.mit.edu. License: Creative Commons BY-NC-SA.
  • Video Link: Session 8: Public Policy.